XNAS:ADBE Adobe Systems Inc Quarterly Report 10-Q Filing - 3/2/2012

Effective Date 3/2/2012

XNAS:ADBE (Adobe Systems Inc): Fair Value Estimate
Premium
XNAS:ADBE (Adobe Systems Inc): Consider Buying
Premium
XNAS:ADBE (Adobe Systems Inc): Consider Selling
Premium
XNAS:ADBE (Adobe Systems Inc): Fair Value Uncertainty
Premium
XNAS:ADBE (Adobe Systems Inc): Economic Moat
Premium
XNAS:ADBE (Adobe Systems Inc): Stewardship
Premium
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________________
 
FORM 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 2, 2012

 or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                   to                   
 
Commission File Number: 0-15175
 
ADOBE SYSTEMS INCORPORATED
(Exact name of registrant as specified in its charter)
_________________________
Delaware
(State or other jurisdiction of
incorporation or organization)
77-0019522
(I.R.S. Employer
Identification No.)

345 Park Avenue, San Jose, California 95110-2704
(Address of principal executive offices and zip code)

(408) 536-6000
(Registrant’s telephone number, including area code)
 _________________________
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes x  No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x  No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
Accelerated filer o
Non-accelerated filer o
(Do not check if a smaller
reporting company)
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o  No x
The number of shares outstanding of the registrant’s common stock as of March 23, 2012 was 496,126,247.
 



ADOBE SYSTEMS INCORPORATED
FORM 10-Q
 
TABLE OF CONTENTS
 
 
 
Page No.

PART I—FINANCIAL INFORMATION
 
Item 1.

 

 

 

 

Item 2.

Item 3.

Item 4.
 
 
 
 

 PART II—OTHER INFORMATION
 
Item 1.

Item 1A.

Item 2.

Item 6.






 

2


PART I—FINANCIAL INFORMATION

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

ADOBE SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value)
 
March 2,
2012
 
December 2,
2011
 
(Unaudited)
 
(*)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
801,263

 
$
989,500

Short-term investments
1,964,855

 
1,922,192

Trade receivables, net of allowances for doubtful accounts of $15,296 and $15,080, respectively
512,211

 
634,373

Deferred income taxes
77,514

 
91,963

Prepaid expenses and other current assets
149,812

 
133,423

Total current assets
3,505,655

 
3,771,451

Property and equipment, net
549,780

 
527,828

Goodwill
4,138,077

 
3,849,217

Purchased and other intangibles, net
637,825

 
545,526

Investment in lease receivable
207,239

 
207,239

Other assets
94,132

 
89,922

Total assets
$
9,132,708

 
$
8,991,183

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 

 
 

Trade payables
$
70,100

 
$
86,660

Accrued expenses
476,140

 
554,941

Capital lease obligations
9,318

 
9,212

Accrued restructuring
36,370

 
80,930

Income taxes payable
30,549

 
42,634

Deferred revenue
492,545

 
476,402

Total current liabilities
1,115,022

 
1,250,779

Long-term liabilities:
 

 
 

Debt and capital lease obligations
1,502,893

 
1,505,096

Deferred revenue
56,419

 
55,303

Accrued restructuring
12,803

 
7,449

Income taxes payable
150,137

 
156,958

Deferred income taxes
254,193

 
181,602

Other liabilities
54,939

 
50,883

Total liabilities
3,146,406

 
3,208,070

Stockholders’ equity:
 

 
 

Preferred stock, $0.0001 par value; 2,000 shares authorized, none issued

 

Common stock, $0.0001 par value; 900,000 shares authorized; 600,834 shares issued; 
    495,928 and 491,540 shares outstanding, respectively
61

 
61

Additional paid-in-capital
2,821,712

 
2,753,896

Retained earnings
6,497,070

 
6,528,735

Accumulated other comprehensive income
46,748

 
29,950

Treasury stock, at cost (104,906 and 109,294 shares, respectively), net of reissuances
(3,379,289
)
 
(3,529,529
)
Total stockholders’ equity
5,986,302

 
5,783,113

Total liabilities and stockholders’ equity
$
9,132,708

 
$
8,991,183

_________________________________________ 
(*)
The Condensed Consolidated Balance Sheet as of December 2, 2011 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.
See accompanying Notes to Condensed Consolidated Financial Statements.

3


ADOBE SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited)
 
Three Months Ended
 
March 2,
2012
 
March 4,
2011
Revenue:
 
 
 
Products
$
808,521

 
$
842,689

Subscription
146,230

 
106,171

Services and support
90,469

 
78,846

Total revenue
1,045,220

 
1,027,706

 
Cost of revenue:
 

 
 
Products
25,668

 
30,717

Subscription
48,780

 
47,878

Services and support
33,817

 
29,044

Total cost of revenue
108,265

 
107,639

 
Gross profit
936,955

 
920,067

 
Operating expenses:
 

 
 
Research and development
177,728

 
178,400

Sales and marketing
358,963

 
328,078

General and administrative
102,681

 
100,979

Restructuring charges
(2,825
)
 
41

Amortization of purchased intangibles
11,429

 
10,235

Total operating expenses
647,976

 
617,733

 
Operating income
288,979

 
302,334

 
Non-operating income (expense):
 

 
 
Interest and other income (expense), net
(2,785
)
 
(817
)
Interest expense
(16,838
)
 
(17,020
)
Investment gains (losses), net
1,021

 
1,590

Total non-operating income (expense), net
(18,602
)
 
(16,247
)
Income before income taxes
270,377

 
286,087

Provision for income taxes
85,168

 
51,496

Net income
$
185,209

 
$
234,591

Basic net income per share
$
0.37

 
$
0.47

Shares used to compute basic net income per share
494,016

 
504,134

Diluted net income per share
$
0.37

 
$
0.46

Shares used to compute diluted net income per share
500,378

 
511,345



  See accompanying Notes to Condensed Consolidated Financial Statements.


4


ADOBE SYSTEMS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
Three Months Ended
 
March 2,
2012
 
March 4,
2011
Cash flows from operating activities:
 
 
 
Net income
$
185,209

 
$
234,591

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 
Depreciation, amortization and accretion
69,861

 
66,286

Stock-based compensation
71,582

 
70,992

Deferred income taxes
63,377

 
28,645

Unrealized gains on investments
(3,168
)
 
(1,330
)
Other non-cash items
(6,650
)
 
2,703

Excess tax benefits from stock-based compensation
(2,670
)
 

Changes in operating assets and liabilities, net of acquired assets and assumed
      liabilities:
 
 
 
Trade receivables, net
152,721

 
20,605

Prepaid expenses and other current assets
(15,080
)
 
(2,716
)
Trade payables
(42,542
)
 
2,310

Accrued expenses
(116,908
)
 
(110,084
)
Accrued restructuring
(39,057
)
 
(2,526
)
Income taxes payable
(19,051
)
 
8,905

Deferred revenue
16,739

 
13,721

Net cash provided by operating activities
314,363

 
332,102

Cash flows from investing activities:
 

 
 

Purchases of short-term investments
(352,179
)
 
(375,077
)
Maturities of short-term investments
112,089

 
134,296

Proceeds from sales of short-term investments
207,672

 
217,407

Acquisitions, net of cash acquired
(353,184
)
 
(36,572
)
Purchases of property and equipment
(51,088
)
 
(32,421
)
Purchases of long-term investments and other assets
(5,203
)
 
(5,389
)
Proceeds from sale of long-term investments
4,186

 
2,755

Other

 
(124
)
Net cash used for investing activities
(437,707
)
 
(95,125
)
Cash flows from financing activities:
 

 
 

Purchases of treasury stock
(80,000
)
 
(125,000
)
Proceeds from issuance of treasury stock
13,366

 
40,651

Excess tax benefits from stock-based compensation
2,670

 

Repayment of debt and capital lease obligations
(2,264
)
 
(2,169
)
Debt issuance costs
(2,297
)
 

Net cash used for financing activities
(68,525
)
 
(86,518
)
Effect of foreign currency exchange rates on cash and cash equivalents
3,632

 
(194
)
Net (decrease) increase in cash and cash equivalents
(188,237
)
 
150,265

Cash and cash equivalents at beginning of period
989,500

 
749,891

Cash and cash equivalents at end of period
$
801,263

 
$
900,156

Supplemental disclosures:
 

 
 
Cash paid for income taxes, net of refunds
$
51,397

 
$
16,413

Cash paid for interest
$
33,883

 
$
31,623

Non-cash investing activities:
 
 
 
Issuance of common stock and stock awards assumed in business acquisitions
$
4,265

 
$
549


See accompanying Notes to Condensed Consolidated Financial Statements.

5


ADOBE SYSTEMS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 
(Unaudited)

NOTE 1.  BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
We have prepared the accompanying unaudited Condensed Consolidated Financial Statements pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Pursuant to these rules and regulations, we have condensed or omitted certain information and footnote disclosures we normally include in our annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). In management’s opinion, we have made all adjustments (consisting only of normal, recurring adjustments, except as otherwise indicated) necessary to fairly present our financial position, results of operations and cash flows. Our interim period operating results do not necessarily indicate the results that may be expected for any other interim period or for the full fiscal year. These financial statements and accompanying notes should be read in conjunction with the consolidated financial statements and notes thereto in our Annual Report on Form 10-K for the fiscal year ended December 2, 2011 on file with the SEC (our “Annual Report”).
There have been no material changes to our significant accounting policies as compared to the significant accounting policies described in our Annual Report.
Recent Accounting Pronouncements 
There have been no new accounting pronouncements during the three months ended March 2, 2012, as compared to the recent accounting pronouncements described in our Annual Report on Form 10-K for the fiscal year ended December 2, 2011, that are of significance, or potential significance, to us.
NOTE 2.  ACQUISITIONS
On January 13, 2012, we completed our acquisition of privately held Efficient Frontier, a multi-channel ad buying and optimization company. During the first quarter of fiscal 2012, we began integrating Efficient Frontier into our Digital Marketing reportable segment. The Efficient Frontier business adds cross-channel ad campaign forecasting, execution and optimization capabilities to our Digital Marketing Suite, along with a social marketing engagement platform and social ad buying capabilities. We have included the financial results of Efficient Frontier in our condensed consolidated financial statements beginning on the acquisition date.
Under the acquisition method of accounting, the total preliminary purchase price was allocated to Efficient Frontier’s net tangible and intangible assets based upon their estimated fair values as of January 13, 2012. The total preliminary purchase price for Efficient Frontier was approximately $374.8 million of which approximately $291.5 million was allocated to goodwill, $122.7 million to identifiable intangible assets and $39.4 million to net liabilities assumed. The impact of this acquisition was not material to our condensed consolidated financial statements.
During fiscal 2011, we completed six business combinations with aggregate purchase prices totaling approximately $281.0 million of which approximately $212.3 million was allocated to goodwill, $87.5 million to identifiable intangible assets and $18.8 million to net liabilities assumed. We also completed two asset acquisitions with aggregate purchase prices totaling $47.3 million. We have included the financial results of the business combinations in our consolidated results of operations beginning on the acquisition dates, however the impact of these acquisitions were not material to our condensed consolidated financial statements.
NOTE 3.  CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
Cash equivalents consist of instruments with remaining maturities of three months or less at the date of purchase. We classify all of our cash equivalents and short-term investments as “available-for-sale.” In general, these investments are free of trading restrictions. We carry these investments at fair value, based on quoted market prices or other readily available market information. Unrealized gains and losses, net of taxes, are included in accumulated other comprehensive income, which is reflected as a separate component of stockholders’ equity in our Condensed Consolidated Balance Sheets. Gains and losses are recognized when realized in our Condensed Consolidated Statements of Income. When we have determined that an other-than-temporary decline in fair value has occurred, the amount of the decline that is related to a credit loss is recognized in income. Gains and losses are determined using the specific identification method.

6


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Cash, cash equivalents and short-term investments consisted of the following as of March 2, 2012 (in thousands):
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Estimated
Fair Value
Current assets:
 
 
 
 
 
 
 
Cash
$
224,267

 
$

 
$

 
$
224,267

Cash equivalents:
 
 
 
 
 
 
 
Corporate bonds and commercial paper
2,250

 

 

 
2,250

Money market mutual funds and repurchase agreements
508,013

 

 

 
508,013

Time deposits
55,325

 

 

 
55,325

U.S. Treasury securities
11,409

 

 
(1
)
 
11,408

Total cash equivalents
576,997

 

 
(1
)
 
576,996

Total cash and cash equivalents
801,264

 

 
(1
)
 
801,263

Short-term fixed income securities:
 
 
 
 
 
 
 
Corporate bonds and commercial paper
1,039,166

 
10,774

 
(605
)
 
1,049,335

Foreign government securities
3,249

 
25

 

 
3,274

Municipal securities
120,696

 
102

 
(1
)
 
120,797

U.S. agency securities
436,659

 
2,205

 
(36
)
 
438,828

U.S. Treasury securities
333,070

 
1,187

 
(33
)
 
334,224

Subtotal
1,932,840

 
14,293

 
(675
)
 
1,946,458

Marketable equity securities
10,533

 
7,864

 

 
18,397

Total short-term investments
1,943,373

 
22,157

 
(675
)
 
1,964,855

Total cash, cash equivalents and short-term investments
$
2,744,637

 
$
22,157

 
$
(676
)
 
$
2,766,118



7


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Cash, cash equivalents and short-term investments consisted of the following as of December 2, 2011 (in thousands):
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Estimated
Fair Value
Current assets:
 
 
 
 
 
 
 
Cash
$
261,206

 
$

 
$

 
$
261,206

Cash equivalents:
 

 
 
 
 
 
 

Corporate bonds and commercial paper
15,948

 

 

 
15,948

Money market mutual funds and repurchase agreements
687,152

 

 

 
687,152

Time deposits
15,694

 

 

 
15,694

U.S. agency securities
2,500

 

 

 
2,500

U.S. Treasury securities
7,000

 

 

 
7,000

Total cash equivalents
728,294

 

 

 
728,294

Total cash and cash equivalents
989,500

 

 

 
989,500

Short-term fixed income securities:
 
 
 
 
 
 
 

Corporate bonds and commercial paper
1,109,674

 
6,533

 
(4,670
)
 
1,111,537

Foreign government securities
7,280

 
43

 

 
7,323

Municipal securities
106,255

 
104

 
(4
)
 
106,355

U.S. agency securities
374,514

 
1,496

 
(117
)
 
375,893

U.S. Treasury securities
307,181

 
1,640

 
(4
)
 
308,817

Subtotal
1,904,904

 
9,816

 
(4,795
)
 
1,909,925

Marketable equity securities
10,581

 
1,686

 

 
12,267

Total short-term investments
1,915,485

 
11,502

 
(4,795
)
 
1,922,192

Total cash, cash equivalents and short-term investments
$
2,904,985

 
$
11,502

 
$
(4,795
)
 
$
2,911,692


See Note 4 for further information regarding the fair value of our financial instruments.
The following table summarizes the fair value and gross unrealized losses related to available-for-sale securities, aggregated by investment category, that have been in an unrealized loss position for less than twelve months, as of March 2, 2012 and December 2, 2011 (in thousands):
 
2012
 
2011
 
Fair 
Value
 
Gross
Unrealized
Losses
 
Fair 
Value
 
Gross
Unrealized
Losses
Corporate bonds and commercial paper
$
137,135

 
$
(576
)
 
$
408,178

 
$
(4,438
)
Municipal securities
8,625

 
(1
)
 
17,125

 
(3
)
U.S. Treasury and agency securities
146,737

 
(70
)
 
133,857

 
(121
)
Total
$
292,497

 
$
(647
)
 
$
559,160

 
$
(4,562
)
 
There were 90 securities and 213 securities that were in an unrealized loss position for less than twelve months at March 2, 2012 and at December 2, 2011, respectively.

8


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

The following table summarizes the fair value and gross unrealized losses related to available-for-sale securities, aggregated by investment category, that have been in a continuous unrealized loss position for more than twelve months, as of March 2, 2012 and December 2, 2011 (in thousands):
 
2012
 
2011
 
Fair 
Value
 
Gross
Unrealized
Losses
 
Fair 
Value
 
Gross
Unrealized
Losses
Corporate bonds and commercial paper
$
13,187

 
$
(29
)
 
$
22,918

 
$
(232
)
Municipal securities

 

 
2,668

 
(1
)
Total
$
13,187

 
$
(29
)
 
$
25,586

 
$
(233
)
There were 7 securities and 13 securities that were in an unrealized loss position for more than twelve months at March 2, 2012 and at December 2, 2011, respectively.
The following table summarizes the cost and estimated fair value of short-term fixed income securities classified as short-term investments based on stated effective maturities as of March 2, 2012 (in thousands):
 
Amortized
Cost
 
Estimated
Fair Value
Due within one year
$
914,746

 
$
916,557

Due between one and two years
496,450

 
500,531

Due between two and three years
418,018

 
423,287

Due after three years
103,626

 
106,083

Total
$
1,932,840

 
$
1,946,458

We review our debt and marketable equity securities classified as short-term investments on a regular basis to evaluate whether or not any security has experienced an other-than-temporary decline in fair value. We consider factors such as the length of time and extent to which the market value has been less than the cost, the financial condition and near-term prospects of the issuer and our intent to sell, or whether it is more likely than not we will be required to sell, the investment before recovery of the investment’s amortized cost basis. If we believe that an other-than-temporary decline exists in one of these securities, we write down these investments to fair value. For debt securities, the portion of the write-down related to credit loss would be recorded to interest and other income, net in our Condensed Consolidated Statements of Income. Any portion not related to credit loss would be recorded to accumulated other comprehensive income, which is reflected as a separate component of stockholders’ equity in our Condensed Consolidated Balance Sheets. For equity securities, the write-down would be recorded to investment gains (losses), net in our Condensed Consolidated Statements of Income. During the three months ended March 2, 2012, we did not consider any of our investments to be other-than-temporarily impaired.

9


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 4.  FAIR VALUE MEASUREMENTS
Financial Assets and Liabilities
We measure certain financial assets and liabilities at fair value on a recurring basis. There have been no transfers between fair value measurement levels during the three months ended March 2, 2012.
The fair value of our financial assets and liabilities at March 2, 2012 was determined using the following inputs (in thousands):
 
  Fair Value Measurements at Reporting Date Using
 
 
 
Quoted Prices
in Active
Markets for
Identical Assets
 
Significant
Other
Observable
Inputs
 
Significant
Unobservable
Inputs
 
Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
Assets:
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
Corporate bonds and commercial paper
$
2,250

 
$

 
$
2,250

 
$

Money market mutual funds and repurchase
    agreements
508,013

 
508,013

 

 

Time deposits
55,325

 
55,325

 

 

U.S. Treasury securities
11,408

 

 
11,408

 

Short-term investments:
 
 
 
 
 
 
 
Corporate bonds and commercial paper
1,049,335

 

 
1,049,335

 

Foreign government securities
3,274

 

 
3,274

 

Marketable equity securities
18,397

 
18,397

 

 

Municipal securities
120,797

 

 
120,797

 

U.S. agency securities
438,828

 

 
438,828

 

U.S. Treasury securities
334,224

 

 
334,224

 

Prepaid expenses and other current assets:
 
 
 

 
 

 
 

Foreign currency derivatives
29,164

 

 
29,164

 

Other assets:
 
 
 

 
 

 
 

Deferred compensation plan assets
15,041

 
375

 
14,666

 

Total assets
$
2,586,056

 
$
582,110

 
$
2,003,946

 
$

Liabilities:
 

 
 

 
 

 
 

Accrued expenses:
 

 
 

 
 

 
 

Foreign currency derivatives
$
4,074

 
$

 
$
4,074

 
$

Total liabilities
$
4,074

 
$

 
$
4,074

 
$



10


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

The fair value of our financial assets and liabilities at December 2, 2011 was determined using the following inputs (in thousands): 
 
  Fair Value Measurements at Reporting Date Using
 
 
 
Quoted Prices
in Active
Markets for
Identical Assets
 
Significant
Other
Observable
Inputs
 
Significant
Unobservable
Inputs
 
Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
Assets:
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
Corporate bonds and commercial paper
$
15,948

 
$

 
$
15,948

 
$

Money market mutual funds and repurchase
    agreements
687,152

 
687,152

 

 

Time deposits
15,694

 
15,694

 

 

U.S. agency securities
2,500

 

 
2,500

 

U.S. Treasury securities
7,000

 

 
7,000

 

Short-term investments:
 

 


 


 


Corporate bonds and commercial paper
1,111,537

 

 
1,111,537

 

Foreign government securities
7,323

 

 
7,323

 

Marketable equity securities
12,267

 
12,267

 

 

Municipal securities
106,355

 

 
106,355

 

U.S. agency securities
375,893

 

 
375,893

 

U.S. Treasury securities 
308,817

 

 
308,817

 

Prepaid expenses and other current assets:
 

 
 

 
 

 
 

Foreign currency derivatives
25,362

 

 
25,362

 

Other assets:
 

 
 

 
 

 
 

Deferred compensation plan assets
12,803

 
523

 
12,280

 

Total assets
$
2,688,651

 
$
715,636

 
$
1,973,015

 
$

Liabilities:
 

 
 

 
 

 
 

Accrued expenses:
 

 
 

 
 

 
 

Foreign currency derivatives
$
3,881

 
$

 
$
3,881

 
$

Total liabilities
$
3,881

 
$

 
$
3,881

 
$


See Note 3 for further information regarding the fair value of our financial instruments. 
Our fixed income available-for-sale securities consist of high quality, investment grade securities from diverse issuers with a minimum credit rating of BBB and a weighted average credit rating of AA-. We value these securities based on pricing from pricing vendors, who may use quoted prices in active markets for identical assets (Level 1 inputs) or inputs other than quoted prices that are observable either directly or indirectly (Level 2 inputs) in determining fair value. However, we classify all of our fixed income available-for-sale securities as having Level 2 inputs. The valuation techniques used to measure the fair value of our financial instruments having Level 2 inputs were derived from pricing models that use non-binding market consensus prices that are corroborated by observable market data or quoted prices for similar instruments. Our procedures include controls to ensure that appropriate fair values are recorded such as comparing prices obtained from multiple independent sources. 
Our deferred compensation plan assets consist of prime money market funds and mutual funds.


11


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Direct Investments
We also have direct investments in privately held companies accounted for under the cost method, which are periodically assessed for other-than-temporary impairment. If we determine that an other-than-temporary impairment has occurred, we write-down the investment to its fair value. We estimate fair value of our cost method investments considering available information such as pricing in recent rounds of financing, current cash positions, earnings and cash flow forecasts, recent operational performance and any other readily available market data. Our cost method investments as of March 2, 2012 and December 2, 2011 were $21.4 million and $21.0 million, respectively. For the three months ended March 2, 2012, we determined there were no other-than-temporary impairments on our cost method investments.
NOTE 5.  DERIVATIVES AND HEDGING ACTIVITIES
In countries outside the U.S., we transact business in U.S. Dollars and in various other currencies. Therefore, we are subject to exposure from movements in foreign currency rates. We may use foreign exchange option contracts or forward contracts to hedge certain operational (“cash flow”) exposures resulting from changes in foreign currency exchange rates. These foreign exchange contracts, carried at fair value, may have maturities between one and twelve months. The maximum original duration of any contract is twelve months. We enter into these foreign exchange contracts to hedge a portion of our forecasted foreign currency denominated revenue in the normal course of business and accordingly, they are not speculative in nature.
We recognize derivative instruments from hedging activities as either assets or liabilities on the balance sheet and measure them at fair value. Gains and losses resulting from changes in fair value are accounted for depending on the use of the derivative and whether it is designated and qualifies for hedge accounting. To receive hedge accounting treatment, all hedging relationships are formally documented at the inception of the hedge, and the hedges must be highly effective in offsetting changes to future cash flows on hedged transactions. We record changes in the intrinsic value of these cash flow hedges in accumulated other comprehensive income in our Condensed Consolidated Balance Sheets, until the forecasted transaction occurs. When the forecasted transaction occurs, we reclassify the related gain or loss on the cash flow hedge to revenue. In the event the underlying forecasted transaction does not occur, or it becomes probable that it will not occur, we reclassify the gain or loss on the related cash flow hedge from accumulated other comprehensive income to interest and other income, net in our Condensed Consolidated Statements of Income at that time.
We also hedge our net recognized foreign currency assets and liabilities with foreign exchange forward contracts to reduce the risk that our earnings and cash flows will be adversely affected by changes in exchange rates. These derivative instruments hedge assets and liabilities that are denominated in foreign currencies and are carried at fair value with changes in the fair value recorded to interest and other income (expense), net in our Condensed Consolidated Statements of Income. These derivative instruments do not subject us to material balance sheet risk due to exchange rate movements because gains and losses on these derivatives are intended to offset gains and losses on the assets and liabilities being hedged.
We mitigate concentration of risk related to foreign currency hedges as well as interest rate hedges through a policy that establishes counterparty limits. The bank counterparties to these contracts expose us to credit-related losses in the event of their nonperformance. However, to mitigate that risk, we only contract with counterparties who meet our minimum requirements as determined by our counterparty risk assessment process. In addition, our hedging policy establishes maximum limits for each counterparty. We monitor ratings, credit spreads and potential downgrades on at least a quarterly basis. Based on our ongoing assessment of counterparty risk, we will adjust our exposure to various counterparties.
The aggregate fair value of derivative instruments in net asset positions as of March 2, 2012 and December 2, 2011 was $29.2 million and $25.4 million, respectively. These amounts represent the maximum exposure to loss at the reporting date as a result of all of the counterparties failing to perform as contracted. This exposure could be reduced by up to $4.1 million and $3.9 million, respectively, of liabilities included in master netting arrangements with those same counterparties.

12


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

The fair value of derivative instruments on our Condensed Consolidated Balance Sheets as of March 2, 2012 and December 2, 2011 were as follows (in thousands):
 
2012
 
2011
 
Fair Value
Asset
Derivatives(1)
 
Fair Value
Liability
Derivatives(2)
 
Fair Value
Asset
Derivatives(1)
 
Fair Value
Liability
Derivatives(2)
Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
Foreign exchange option contracts(3) 
$
19,929

 
$

 
$
19,296

 
$

Derivatives not designated as hedging instruments:


 


 


 


 Foreign exchange forward contracts
9,235

 
4,074

 
6,066

 
3,881

Total derivatives
$
29,164

 
$
4,074

 
$
25,362

 
$
3,881

_________________________________________ 
(1) 
Included in prepaid expenses and other current assets on our Condensed Consolidated Balance Sheets.
(2) 
Included in accrued expenses on our Condensed Consolidated Balance Sheets.
(3) 
Hedging effectiveness expected to be recognized to income within the next twelve months.
 
The effect of derivative instruments designated as cash flow hedges and of derivative instruments not designated as hedges in our Condensed Consolidated Statements of Income for three months ended March 2, 2012 and March 4, 2011 was as follows (in thousands):
 
2012
 
2011
 
Foreign
Exchange
Option
Contracts
 
Foreign
Exchange
Forward
Contracts
 
Foreign
Exchange
Option
Contracts
 
Foreign
Exchange
Forward
Contracts
Derivatives in cash flow hedging relationships:
 
 
 
 
 
 
 
Net gain (loss) recognized in OCI, net of tax(1) 
$
12,581

 
$

 
$
67

 
$

Net gain (loss) reclassified from accumulated
OCI into income, net of tax(2)
$
10,348

 
$

 
$

 
$

Net gain (loss) recognized in income(3) 
$
(8,245
)
 
$

 
$
(8,306
)
 
$

Derivatives not designated as hedging relationships:


 


 
 
 
 
Net gain (loss) recognized in income(4) 
$

 
$
8,150

 
$

 
$
(10,150
)
_________________________________________ 
(1) 
Net change in the fair value of the effective portion classified in other comprehensive income (“OCI”).
(2) 
Effective portion classified as revenue.
(3) 
Ineffective portion and amount excluded from effectiveness testing classified in interest and other income (expense), net.
(4) 
Classified in interest and other income (expense), net.
NOTE 6.  GOODWILL AND PURCHASED AND OTHER INTANGIBLES
Goodwill as of March 2, 2012 and December 2, 2011 was $4.138 billion and $3.849 billion, respectively. The increase was primarily due to our acquisition of Efficient Frontier and foreign currency translation adjustments.

13


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Purchased and other intangible assets subject to amortization as of March 2, 2012 and December 2, 2011 were as follows (in thousands): 
 
2012
 
2011
 
Cost
 
Accumulated Amortization
 
Net
 
Cost
 
Accumulated Amortization
 
Net
Purchased technology
$
367,340

 
$
(107,305
)
 
$
260,035

 
$
314,057

 
$
(91,363
)
 
$
222,694

Customer contracts and relationships
$
313,714

 
$
(53,108
)
 
$
260,606

 
$
433,534

 
$
(229,364
)
 
$
204,170

Trademarks
53,333

 
(13,180
)
 
40,153

 
52,734

 
(11,217
)
 
41,517

Acquired rights to use technology
106,565

 
(51,024
)
 
55,541

 
106,865

 
(48,137
)
 
58,728

Localization
11,185

 
(6,610
)
 
4,575

 
9,762

 
(6,591
)
 
3,171

Other intangibles
22,728

 
(5,813
)
 
16,915

 
63,906

 
(48,660
)
 
15,246

Total other intangible assets
$
507,525

 
$
(129,735
)
 
$
377,790

 
$
666,801

 
$
(343,969
)
 
$
322,832

Purchased and other intangible
    assets, net
$
874,865

 
$
(237,040
)
 
$
637,825

 
$
980,858

 
$
(435,332
)
 
$
545,526

 
Amortization expense related to purchased and other intangible assets was $33.1 million for both the three months ended March 2, 2012 and March 4, 2011. Of this amount, $21.6 million and $22.9 million were included in cost of sales for the three months ended March 2, 2012 and March 4, 2011, respectively.
As of March 2, 2012, we expect amortization expense in future periods to be as follows (in thousands):
Fiscal Year
 
Purchased
Technology
 
Other Intangible
Assets
Remainder of 2012
$
56,341

 
$
50,786

2013
70,173

 
59,733

2014
63,964

 
55,686

2015
49,329

 
49,920

2016
11,495

 
44,436

Thereafter
8,733

 
117,229

Total expected amortization expense
$
260,035

 
$
377,790

NOTE 7.  ACCRUED EXPENSES
Accrued expenses as of March 2, 2012 and December 2, 2011 consisted of the following (in thousands):
 
2012
 
2011
Accrued compensation and benefits
$
155,440

 
$
235,500

Sales and marketing allowances 
52,633

 
58,156

Accrued corporate marketing
51,351

 
37,757

Taxes payable
20,255

 
26,732

Royalties payable
15,815

 
18,778

Accrued interest expense
5,448

 
21,010

Other
175,198

 
157,008

Accrued expenses                                                                                         
$
476,140

 
$
554,941


Other primarily includes general corporate accruals for local and regional expenses and technical support. Other is also comprised of deferred rent related to office locations with rent escalations and foreign currency liability derivatives.

14


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 8.  STOCK-BASED COMPENSATION
The assumptions used to value option grants during the three months ended March 2, 2012 and March 4, 2011 were as follows: 
 
2012
 
2011
Expected life (in years)
3.9

 
3.8 - 4.1
Volatility
34
%
 
31 - 35%
Risk free interest rate
0.54
%
 
1.46 - 1.92%

The expected life of employee stock purchase plan (“ESPP”) shares is the average of the remaining purchase periods under each offering period. The assumptions used to value employee stock purchase rights during the three months ended March 2, 2012 and March 4, 2011 were as follows:
 
2012
 
2011
Expected life (in years)
0.5 - 2.0
 
0.5 - 2.0
Volatility
36%
 
32 - 34%
Risk free interest rate
0.06 - 0.27%
 
0.19 - 0.61%
 
Summary of Stock Options 
Option activity for the three months ended March 2, 2012 and the fiscal year ended December 2, 2011 was as follows (in thousands):
 
2012
 
2011
Beginning outstanding balance
34,802

 
37,075

Granted
15

 
4,507

Exercised
(1,760
)
 
(4,987
)
Cancelled
(1,566
)
 
(2,268
)
Increase due to acquisition
1,103

 
475

Ending outstanding balance
32,594

 
34,802

 
Information regarding stock options outstanding at March 2, 2012 and March 4, 2011 is summarized below:
 
Number of
Shares
(thousands)
 
Weighted
Average
Exercise
Price
 
Weighted
Average
Remaining
Contractual
Life
(years)
 
Aggregate
Intrinsic
Value(*)
(millions)
2012
 
 
 
 
 
 
 
Options outstanding
32,594

 
$
30.97

 
3.14
 
$
148.4

Options vested and expected to vest
31,783

 
$
31.08

 
3.07
 
$
142.4

Options exercisable
25,490

 
$
32.61

 
2.39
 
$
85.2

2011
 

 
 

 
 
 
 

Options outstanding
38,529

 
$
31.18

 
3.80
 
$
203.1

Options vested and expected to vest
36,857

 
$
31.22

 
3.70
 
$
194.6

Options exercisable
26,948

 
$
31.92

 
2.95
 
$
133.1

_________________________________________ 
(*) 
The intrinsic value is calculated as the difference between the market value as of the end of the fiscal period and the exercise price of the shares. As reported by the NASDAQ Global Select Market, the market values as of March 2, 2012 and March 4, 2011 were $33.73 and $35.27, respectively.

15


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Summary of Employee Stock Purchase Plan Shares
Employees purchased 1.1 million shares at an average price of $23.64 and 1.4 million shares at an average price of $20.61 for the three months ended March 2, 2012 and March 4, 2011, respectively. The intrinsic value of shares purchased during the three months ended March 2, 2012 and March 4, 2011 was $5.0 million and $15.3 million, respectively. The intrinsic value is calculated as the difference between the market value on the date of purchase and the purchase price of the shares.
Summary of Restricted Stock Units
Restricted stock unit activity for the three months ended March 2, 2012 and the fiscal year ended December 2, 2011 was as follows (in thousands):
 
2012
 
2011
Beginning outstanding balance
16,871

 
13,890

Awarded
6,964

 
8,180

Released
(4,631
)
 
(3,819
)
Forfeited
(965
)
 
(1,587
)
Increase due to acquisition
111

 
207

Ending outstanding balance
18,350

 
16,871

 
Information regarding restricted stock units outstanding at March 2, 2012 and March 4, 2011 is summarized below:
 
Number of
Shares
(thousands)
 
Weighted
Average
Remaining
Contractual
Life
(years)
 
Aggregate
Intrinsic
Value(*)
(millions)
2012
 
 
 
 
 
Restricted stock units outstanding
18,350

 
1.90
 
$
618.9

Restricted stock units vested and expected to vest
15,432

 
1.79
 
$
519.6

2011
 

 
 
 
 

Restricted stock units outstanding
17,923

 
1.92
 
$
632.1

Restricted stock units vested and expected to vest
13,661

 
1.75
 
$
481.1

_________________________________________ 
(*) 
The intrinsic value is calculated as the market value as of the end of the fiscal period. As reported by the NASDAQ Global Select Market, the market values as of March 2, 2012 and March 4, 2011 were $33.73 and $35.27, respectively. 
Summary of Performance Shares 
Effective January 24, 2012, the Executive Compensation Committee adopted the 2012 Performance Share Program (the “2012 Program”). The purpose of the 2012 Program is to align key management and senior leadership with stockholders’ interests and to retain key employees. The measurement period for the 2012 Program is our fiscal 2012 year. All members of our executive management and other key senior management are participating in the 2012 Program. Awards granted under the 2012 Program are granted in the form of performance shares pursuant to the terms of our 2003 Equity Incentive Plan. If pre-determined Adobe specific or market based performance goals are met, shares of stock will be granted to the recipient, with one third vesting on the later of the date of certification of achievement or the first anniversary date of the grant, and the remaining two thirds vesting evenly on the following two annual anniversary dates of the grant, contingent upon the recipient’s continued service to Adobe. Participants in the 2012 Program have the ability to receive up to 150% of the target number of shares originally granted.

16


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

The following table sets forth the summary of performance share activity under our 2012 Program for the three months ended March 2, 2012 (in thousands): 
 
Shares
Granted
 
Maximum
Shares Eligible
to Receive
Beginning outstanding balance

 

Awarded
1,125

 
1,688

Forfeited

 

Ending outstanding balance
1,125

 
1,688


In the first quarter of fiscal 2012, the Executive Compensation Committee certified the actual performance achievement of participants in the 2011 Performance Share Program (the “2011 Program”). Based upon the achievement of goals outlined in the 2011 Program, participants had the ability to receive up to 150% of the target number of shares originally granted. Actual performance resulted in participants achieving 130% of target or approximately 0.5 million shares for the 2011 Program. One third of the shares under the 2011 Program vested in the first quarter of fiscal 2012 and the remaining two thirds vest evenly on the following two annual anniversary dates of the grant, contingent upon the recipient's continued service to Adobe.
The performance metrics under the 2009 Performance Share Program were not achieved and therefore no shares were awarded.
The following table sets forth the summary of performance share activity under our 2007, 2008, 2010 and 2011 programs, based upon share awards actually achieved, for the three months ended March 2, 2012 and the fiscal year ended December 2, 2011 (in thousands):
 
2012
 
2011
Beginning outstanding balance
405

 
557

Achieved
492

 
337

Released
(442
)
 
(436
)
Forfeited
(2
)
 
(53
)
Ending outstanding balance
453

 
405

 
Information regarding performance shares outstanding at March 2, 2012 and March 4, 2011 is summarized below: 
 
Number of
Shares
(thousands)
 
Weighted
Average
Remaining
Contractual
Life
(years)
 
Aggregate
Intrinsic
Value(*)
(millions)
2012
 
 
 
 
 
Performance shares outstanding
453

 
1.23
 
$
15.3

Performance shares vested and expected to vest
403

 
1.20
 
$
13.5

2011
 

 
 
 
 

Performance shares outstanding
469

 
1.11
 
$
16.6

Performance shares vested and expected to vest
401

 
1.08
 
$
13.9

_________________________________________ 
(*) 
The intrinsic value is calculated as the market value as of the end of the fiscal period. As reported by the NASDAQ Global Select Market, the market values as of March 2, 2012 and March 4, 2011 were $33.73 and $35.27, respectively.     
Compensation Costs
As of March 2, 2012, there was $608.3 million of unrecognized compensation cost, adjusted for estimated forfeitures, related to non-vested stock-based awards which will be recognized over a weighted average period of 2.7 years. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures.

17


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Total stock-based compensation costs that have been included in our Condensed Consolidated Statements of Income for the three months ended March 2, 2012 and March 4, 2011 were as follows (in thousands):
 
 
2012
 
2011
Income Statement Classifications
 
Option
Grants
and Stock
Purchase
Rights
 
Restricted
Stock and
Performance
Share
Awards
 
Option
Grants
and Stock
Purchase
Rights
 
Restricted
Stock and
Performance
Share
Awards 
Cost of revenue—subscription
$
742

 
$
603

 
$
192

 
$
321

Cost of revenue—services and support
1,116

 
2,070

 
1,095

 
2,075

Research and development
7,199

 
18,081

 
6,755

 
20,578

Sales and marketing
8,780

 
16,916

 
7,550

 
16,416

General and administrative
4,500

 
11,574

 
5,949

 
10,061

Total
$
22,337

 
$
49,244

 
$
21,541

 
$
49,451

NOTE 9.  RESTRUCTURING CHARGES
Fiscal 2011 Restructuring Plan
In the fourth quarter of fiscal 2011, we initiated a restructuring plan consisting of reductions in workforce and the consolidation of facilities in order to better align our resources around our Digital Media and Digital Marketing strategies.
During the first quarter of fiscal 2012, we continued to implement restructuring activities under this plan. We vacated approximately 54,000 square feet of sales and/or research and development facilities in Canada, the Czech Republic, Germany and Israel. We accrued $9.8 million for the fair value of our future contractual obligations under those operating leases using our estimated credit-adjusted risk-free interest rates ranging from approximately 1% to 4% as of the dates we ceased to use the leased properties. This amount is net of the fair value of future estimated sublease income of approximately $4.2 million. Total costs incurred for termination benefits through the first quarter of fiscal 2012 was $63.3 million which includes favorable adjustments of $15.3 million recorded during the first quarter of fiscal 2012 arising from revisions to severance cost estimates that were made in connection with the fourth quarter fiscal 2011 restructuring plan. Total costs incurred to date and expected to be incurred for closing redundant facilities are $13.2 million and $14.7 million, respectively.
Other Restructuring Plans
Other restructuring plans include other Adobe plans and other plans associated with certain of our acquisitions that are substantially complete. We continue to make cash outlays to settle obligations under these plans, however the current impact to our condensed consolidated financial statements is not significant. Our other restructuring plans consist of the following:
Fiscal 2009 Restructuring Plan—In the fourth quarter of fiscal 2009, in order to appropriately align our costs in connection with our fiscal 2010 operating plan, we initiated a restructuring plan consisting of reductions in workforce and the consolidation of facilities. The restructuring activities related to this program affected only those employees and facilities that were associated with Adobe prior to the acquisition of Omniture, Inc. ("Omniture") on October 23, 2009. As of March 2, 2012, the remaining balance under our Fiscal 2009 Plan for termination benefits and closing redundant facilities was $1.0 million and $8.5 million, respectively.
Omniture Restructuring Plan—We completed our acquisition of Omniture on October 23, 2009. In the fourth quarter of fiscal 2009, we initiated a plan to restructure the pre-merger operations of Omniture to eliminate certain duplicative activities, focus our resources on future growth opportunities and reduce our cost structure. As of March 2, 2012, the remaining balance under our Omniture Plan for termination benefits and closing redundant facilities was $0.5 million and $1.4 million, respectively.



18


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Fiscal 2008 Restructuring Plan—In the fourth quarter of fiscal 2008, we initiated a restructuring program consisting of reductions in workforce and the consolidation of facilities, in order to reduce our operating costs and focus our resources on key strategic priorities. As of March 2, 2012, the remaining balance under our Fiscal 2008 Plan for closing redundant facilities was $2.1 million. Restructuring activities for termination benefits were completed during fiscal 2011.
Summary of Restructuring Plans
The following table sets forth a summary of restructuring activities related to all of our restructuring plans described above during the three months ended March 2, 2012 (in thousands):
 
December 2,
2011
 
Costs
Incurred
 
Cash
Payments
 
Other
Adjustments
 
March 2,
2012
Fiscal 2011 Restructuring Plan:
 
 
 
 
 
 
 
 
 
Termination benefits
$
72,817

 
$

 
$
(34,238
)
 
$
(15,559
)
 
$
23,020

Cost of closing redundant facilities
2,995

 
9,807

 
(835
)
 
99

 
12,066

Other Restructuring Plans:
 
 
 
 
 
 
 
 
 
Termination benefits
1,548

 
616

 
(96
)
 
(23
)
 
2,045

Cost of closing redundant facilities
11,019

 
830

 
(1,064
)
 
1,257

 
12,042

Total restructuring plans
$
88,379

 
$
11,253

 
$
(36,233
)
 
$
(14,226
)
 
$
49,173

Accrued restructuring charges of approximately $49.2 million as of March 2, 2012 includes $36.4 million recorded in accrued restructuring, current and $12.8 million related to long-term facilities obligations recorded in accrued restructuring, non-current on our Condensed Consolidated Balance Sheets. We expect to pay accrued termination benefits through the remainder of fiscal 2012 and facilities-related liabilities under contract through fiscal 2021.
NOTE 10.  STOCKHOLDERS’ EQUITY
Retained Earnings
The changes in retained earnings for the three months ended March 2, 2012 were as follows (in thousands): 
Balance as of December 2, 2011
$
6,528,735

Net income
185,209

Re-issuance of treasury stock
(216,874
)
Balance as of March 2, 2012
$
6,497,070

We account for treasury stock under the cost method. When treasury stock is re-issued at a price higher than its cost, the difference is recorded as a component of additional paid-in-capital in our Condensed Consolidated Balance Sheets. When treasury stock is re-issued at a price lower than its cost, the difference is recorded as a component of additional paid-in-capital to the extent that there are gains to offset the losses. If there are no treasury stock gains in additional paid-in-capital, the losses upon re-issuance of treasury stock are recorded as a component of retained earnings in our Condensed Consolidated Balance Sheets.

19


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Comprehensive Income
The following table sets forth the activity for each component of comprehensive income, net of related taxes, for the three months ended March 2, 2012 and March 4, 2011 (in thousands):
 
2012
 
2011
 
Increase/(Decrease)
Net income
$
185,209

 
$
234,591

Other comprehensive income:
 

 
 
Available-for-sale securities:
 

 
 
Unrealized gains (losses) on available-for-sale securities
12,864

 
(53
)
Reclassification adjustment for gains on available-for-sale
    securities recognized during the period
(497
)
 
(544
)
Subtotal available-for-sale securities
12,367

 
(597
)
Derivatives designated as hedging instruments:
 

 
 
Unrealized gains on derivative instruments
12,581

 
(67
)
Reclassification adjustment for gains on derivative
    instruments recognized during the period
(10,348
)
 

Subtotal derivatives designated as hedging
     instruments
2,233

 
(67
)
Foreign currency translation adjustments
2,198

 
11,931

Other comprehensive income
16,798

 
11,267

Total comprehensive income, net of taxes
$
202,007

 
$
245,858

The following table sets forth the components of accumulated other comprehensive income, net of related taxes, as of March 2, 2012 and December 2, 2011 (in thousands):
 
2012
 
2011
Net unrealized gains on available-for-sale securities:
 
 
 
Unrealized gains on available-for-sale securities
$
19,060

 
$
10,810

Unrealized losses on available-for-sale securities
(676
)
 
(4,794
)
Total net unrealized gains on available-for-sale securities
18,384

 
6,016

Net unrealized gains on derivative instruments designated as hedging instruments
15,586

 
13,354

Cumulative foreign currency translation adjustments
12,778

 
10,580

Total accumulated other comprehensive income, net of taxes
$
46,748

 
$
29,950

Stock Repurchase Program 
To facilitate our stock repurchase program, designed to return value to our stockholders and minimize dilution from stock issuances, we repurchase shares in the open market and also enter into structured repurchase agreements with third parties.
We currently have authority granted by our Board of Directors to repurchase up to $1.6 billion in common stock through the end of fiscal 2012.
During the three months ended March 2, 2012 and March 4, 2011, we entered into a structured stock repurchase agreement with a large financial institution, whereupon we provided them with a prepayment of $80.0 million and $125.0 million, respectively. We enter into these agreements in order to take advantage of repurchasing shares at a guaranteed discount to the Volume Weighted Average Price (“VWAP”) of our common stock over a specified period of time. We only enter into such transactions when the discount that we receive is higher than the foregone return on our cash prepayments to the financial institutions. There were no explicit commissions or fees on these structured repurchases. Under the terms of the agreements, there is no requirement for the financial institutions to return any portion of the prepayment to us.

20


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

The financial institutions agree to deliver shares to us at monthly intervals during the contract term. The parameters used to calculate the number of shares deliverable are: the total notional amount of the contract, the number of trading days in the contract, the number of trading days in the interval and the average VWAP of our stock during the interval less the agreed upon discount. During the three months ended March 2, 2012, we repurchased approximately 1.8 million shares at an average price of $30.07 through structured repurchase agreements entered into during the three months ended March 2, 2012. During the three months ended March 4, 2011, we repurchased approximately 2.5 million shares at an average price of $32.84 through structured repurchase agreements entered into during the three months ended March 4, 2011.
As of March 2, 2012 and December 2, 2011, the prepayments were classified as treasury stock on our Condensed Consolidated Balance Sheets at the payment date, though only shares physically delivered to us by the financial statement date were excluded from the computation of earnings per share. As of March 2, 2012, approximately $26.8 million in prepayments remained under these agreements. As of December 2, 2011, no prepayments remained under these agreements.
Subsequent to March 2, 2012, as part of our $1.6 billion stock repurchase program, we entered into a structured stock repurchase agreement with a large financial institution whereupon we provided them with a prepayment of $225.0 million. This amount will be classified as treasury stock on our Consolidated Balance Sheets. Upon completion of the $225.0 million stock repurchase agreement, there is no remaining balance under our current authority, although the Board of Directors could grant additional authority in the future. See Note 16 for further discussion of our stock repurchase program.
NOTE 11.  NET INCOME PER SHARE
 
The following table sets forth the computation of basic and diluted net income per share for the three months ended March 2, 2012 and March 4, 2011 (in thousands, except per share data):
 
2012
 
2011
Net income
$
185,209

 
$
234,591

Shares used to compute basic net income per share
494,016

 
504,134

Dilutive potential common shares:
 
 
 
Unvested restricted stock and performance share awards
4,280

 
3,764

Stock options
2,082

 
3,447

Shares used to compute diluted net income per share
500,378

 
511,345

Basic net income per share
$
0.37

 
$
0.47

Diluted net income per share
$
0.37

 
$
0.46

For the three months ended March 2, 2012, options to purchase approximately 26.1 million shares of common stock with exercise prices greater than the average fair market value of our stock of $30.16 were not included in the calculation because the effect would have been anti-dilutive. Comparatively, for the three months ended March 4, 2011, options to purchase approximately 21.9 million shares of common stock with exercise prices greater than the average fair market value of our stock of $32.35 were not included in the calculation because the effect would have been anti-dilutive.
NOTE 12.  COMMITMENTS AND CONTINGENCIES
Lease Commitments
We occupy three office buildings in San Jose, California where our corporate headquarters are located. We reference these office buildings as the Almaden Tower and the East and West Towers.
The lease agreements for the East and West Towers and the Almaden Tower are effective through August 2014 and March 2017, respectively. We are the investors in the lease receivables related to these leases for the East and West Towers and the Almaden Tower in the amount of $126.8 million and $80.4 million, respectively, which is recorded as investment in lease receivables on our Condensed Consolidated Balance Sheets. As of March 2, 2012, the carrying value of the lease receivables related to the towers approximated fair value. Under the agreement for the East and West Towers and the agreement for the Almaden Tower, we have the option to purchase the buildings at any time during the lease term for approximately $143.2 million and $103.6 million, respectively. The residual value guarantees under the East and West Towers and the Almaden Tower obligations

21


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

are $126.8 million and $89.4 million, respectively. If we purchase the properties, the investments in the lease receivables may be credited against the purchase price.
These two leases are both subject to standard covenants including certain financial ratios that are reported to the lessors quarterly. In August 2009, we were required to obtain a standby letter of credit for approximately $16.5 million which enabled us to secure a lower interest rate and reduce the number of covenants. As defined in the lease agreement, the standby letter of credit primarily represents the lease investment equity balance which is callable in the event of default. As of March 2, 2012, we were in compliance with all of the covenants. In the case of a default, the lessor may demand we purchase the buildings for an amount equal to the lease balance, or require that we remarket or relinquish the buildings. If we choose to remarket or are required to do so upon relinquishing the buildings, we are bound to arrange the sale of the buildings to an unrelated party and will be required to pay the lessor any shortfall between the net remarketing proceeds and the lease balance, up to the residual value guarantee amount less our investment in the lease receivables. Both leases qualify for operating lease accounting treatment and, as such, the buildings and the related obligations are not included in our Condensed Consolidated Balance Sheets. 
In June 2010, we entered into a sale-leaseback agreement to sell equipment totaling $32.2 million and leaseback the same equipment over a period of 43 months. This transaction was classified as a capital lease obligation and recorded at fair value. See Note 13 for further discussion of our capital lease obligation.
Royalties
We have royalty commitments associated with the shipment and licensing of certain products. Royalty expense is generally based on a dollar amount per unit shipped or a percentage of the underlying revenue.
Indemnifications
In the normal course of business, we provide indemnifications of varying scope to customers against claims of intellectual property infringement made by third parties arising from the use of our products and from time to time, we are subject to claims by our customers under these indemnification provisions. Historically, costs related to these indemnification provisions have not been significant and we are unable to estimate the maximum potential impact of these indemnification provisions on our future results of operations.
To the extent permitted under Delaware law, we have agreements whereby we indemnify our directors and officers for certain events or occurrences while the director or officer is or was serving at our request in such capacity. The indemnification period covers all pertinent events and occurrences during the director’s or officer’s lifetime. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited; however, we have director and officer insurance coverage that limits our exposure and enables us to recover a portion of any future amounts paid. We believe the estimated fair value of these indemnification agreements in excess of applicable insurance coverage is minimal.
Legal Proceedings
In connection with disputes relating to the validity or alleged infringement of third-party intellectual property rights, including patent rights, we have been, are currently and may in the future be subject to claims, negotiations or complex, protracted litigation. Intellectual property disputes and litigation may be very costly and can be disruptive to our business operations by diverting the attention and energies of management and key technical personnel. Although we have successfully defended or resolved past litigation and disputes, we may not prevail in any ongoing or future litigation and disputes. Third-party intellectual property disputes could subject us to significant liabilities, require us to enter into royalty and licensing arrangements on unfavorable terms, prevent us from licensing certain of our products or offering certain of our services, subject us to injunctions restricting our sale of products or services, cause severe disruptions to our operations or the markets in which we compete, or require us to satisfy indemnification commitments with our customers including contractual provisions under various license arrangements and service agreements.
In October 2009, Eolas Technologies Incorporated filed a complaint against us and 23 other companies for patent infringement in the United States District Court for the Eastern District of Texas. The complaint alleged, among other things, that a number of our Web pages and products infringe two patents owned by the plaintiff purporting to cover “Distributed Hypermedia Method for Automatically Invoking External Application Providing Interaction and Display of Embedded Objects within a Hypermedia Document” (U.S. Patent No. 5,838,906) and “Distributed Hypermedia Method and System for Automatically

22


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Invoking External Application Providing Interaction and Display of Embedded Objects within a Hypermedia Document” (U.S. Patent No. 7,599,985) and sought injunctive relief, monetary damages, costs and attorneys’ fees. Adobe disputed these claims and vigorously defended itself in this matter. On February 9, 2012, a jury found all asserted patent claims in the above-mentioned Eolas patents invalid. On February 27, 2012 Adobe was dismissed from the case. 
In January 2010, Tarkus Imaging, Inc. filed a complaint against us for patent infringement in the United States District Court for the District of Delaware. Also named in the lawsuit were Canon U.S.A., Inc.; Nikon Americas, Inc.; and Nikon, Inc. The plaintiff alleges, among other things, that certain functionality of the Adobe Camera Raw module infringes a patent owned by plaintiff. The complaint seeks injunctive relief, monetary damages, costs and attorneys' fees. We dispute the plaintiff's claims and intend to vigorously defend ourselves in this matter. We have filed a motion for summary judgment, which motion remains pending, and the case is currently scheduled to go to trial in June 2012. As of March 2, 2012, no amounts have been accrued as a loss is not considered probable or estimable.
In addition to intellectual property disputes, such as those discussed above and others, we are subject to legal proceedings, claims and investigations in the ordinary course of business, including claims relating to commercial, employment and other matters. Some of these disputes and legal proceedings may include speculative claims for substantial or indeterminate amounts of damages. We make a provision for a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. These provisions are reviewed at least quarterly and adjusted to reflect the impacts of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular case. All legal costs associated with litigation are expensed as incurred. Litigation is inherently unpredictable. However, we believe that we have valid defenses with respect to the legal matters pending against us. It is possible, nevertheless, that our consolidated financial position, cash flows or results of operations could be negatively affected by an unfavorable resolution of one or more of such proceedings, claims or investigations.
In connection with our anti-piracy efforts, conducted both internally and through organizations such as the Business Software Alliance, from time to time we undertake litigation against alleged copyright infringers. Such lawsuits may lead to counter-claims alleging improper use of litigation or violation of other laws. We believe we have valid defenses with respect to such counter-claims; however, it is possible that our consolidated financial position, cash flows or results of operations could be affected in any particular period by the resolution of one or more of these counter-claims.
NOTE 13.  DEBT
 Notes
In February 2010, we issued $600.0 million of 3.25% senior notes due February 1, 2015 (the “2015 Notes”) and $900.0 million of 4.75% senior notes due February 1, 2020 (the “2020 Notes” and, together with the 2015 Notes, the “Notes”). Our proceeds were approximately $1.5 billion and were net of an issuance discount of $6.6 million. The Notes rank equally with our other unsecured and unsubordinated indebtedness. In addition, we incurred issuance costs of approximately $10.7 million. Both the discount and issuance costs are being amortized to interest expense over the respective terms of the Notes using the effective interest method. The effective interest rate including the discount and issuance costs is 3.45% for the 2015 Notes and 4.92% for the 2020 Notes. Interest is payable semi-annually, in arrears, on February 1 and August 1, commencing on August 1, 2010. In February 2012, we made a semi-annual interest payment of $31.1 million. The proceeds from the Notes are available for general corporate purposes, including repayment of any balance outstanding on our credit facility. Based on quoted market prices, the fair value of the Notes was approximately $1.6 billion as of March 2, 2012.
We may redeem the Notes at any time, subject to a make-whole premium. In addition, upon the occurrence of certain change of control triggering events, we may be required to repurchase the Notes, at a price equal to 101% of their principal amount, plus accrued and unpaid interest to the date of repurchase. The Notes also include covenants that limit our ability to grant liens on assets and to enter into sale and leaseback transactions, subject to significant allowances. As of March 2, 2012, we were in compliance with all of the covenants.
Credit Agreement
On March 2, 2012, we entered into a five-year $1.0 billion senior unsecured revolving credit agreement (the “Credit Agreement”), providing for loans to us and certain of our subsidiaries. Pursuant to the terms of the Credit Agreement, we may,

23


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

subject to the agreement of the applicable lenders, request up to an additional $500.0 million in commitments, for a maximum aggregate commitment of $1.5 billion. Loans under the Credit Agreement will bear interest at either (i) the London Interbank Offered Rate (“LIBOR”) plus a margin, based on our debt ratings, ranging from 0.795% and 1.30% or (ii) the base rate, which is defined as the highest of (a) the agent’s prime rate, (b) the federal funds effective rate plus 0.50% or (c) LIBOR plus 1.00% plus a margin, based on our debt ratings, ranging from 0.00% to 0.30%. Commitment fees are payable quarterly at rates between 0.08% and 0.20% per year also based on our public debt ratings. Subject to certain conditions stated in the Credit Agreement, we and any of our subsidiaries designated as additional borrowers may borrow, prepay and re-borrow amounts under the revolving credit facility at any time during the term of the Credit Agreement. The facility will be used for general corporate purposes.
The Credit Agreement contains customary representations, warranties, affirmative and negative covenants, including a financial covenant, events of default and indemnification provisions in favor of the lenders. The negative covenants include restrictions regarding the incurrence of liens and indebtedness, certain merger and acquisition transactions, dispositions and other matters, all subject to certain exceptions. The financial covenant, based on a quarterly financial test, requires us not to exceed a maximum leverage ratio.
The Credit Agreement will terminate and all amounts owing thereunder will be due and payable on March 2, 2017 unless (a) the commitments are terminated earlier upon the occurrence of certain events, including events of default, or (b) the maturity date is extended upon our request, subject to the agreement of the lenders.
As of March 2, 2012, there were no outstanding borrowings under this Credit Agreement and we were in compliance with all covenants. In connection with entering into the Credit Agreement as described above, we have terminated and paid off all obligations under our previous credit agreement, dated as of February 16, 2007. 
Capital Lease Obligation
In June 2010, we entered into a sale-leaseback agreement to sell equipment totaling $32.2 million and leaseback the same equipment over a period of 43 months. This transaction was classified as a capital lease obligation and recorded at fair value. As of March 2, 2012, our capital lease obligations of $17.4 million includes $9.3 million of current debt.
NOTE 14.  NON-OPERATING INCOME (EXPENSE)

 Non-operating income (expense) for the three months ended March 2, 2012 and March 4, 2011 included the following (in thousands):
 
2012
 
2011
Interest and other income (expense), net:
 
 
 
Interest income
$
6,193

 
$
6,099

Foreign exchange gains (losses)
(9,721
)
 
(7,774
)
Realized gains on fixed income investment
702

 
605

Realized losses on fixed income investment
(205
)
 
(61
)
Other
246

 
314

Interest and other income (expense), net
$
(2,785
)
 
$
(817
)
Interest expense
$
(16,838
)
 
$
(17,020
)
Investment gains (losses), net:
 

 
 
Realized investment gains
$
245

 
$
1,802

Unrealized investment gains
810

 
438

Realized investment losses
(34
)
 
(650
)
Unrealized investment losses

 

Investment gains (losses), net
$
1,021

 
$
1,590

Non-operating income (expense), net
$
(18,602
)
 
$
(16,247
)

24


ADOBE SYSTEMS INCORPORATED

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 15.  SEGMENTS

We report segment information based on the “management” approach. The management approach designates the internal reporting used by management for making decisions and assessing performance as the source of our reportable segments.
Our CEO, the chief operating decision maker, reviews revenue and gross margin information for each of our reportable segments. Operating expenses are not reviewed on a segment by segment basis. In addition, with the exception of goodwill and intangible assets, we do not identify or allocate our assets by the reportable segments.
Effective in the first quarter of fiscal 2012, we modified our segments due to changes in how we operate our business. We combined our Creative and Interactive Solutions segment with our Digital Media Solutions segment and our Knowledge Worker segment, and named it Digital Media. We also renamed our Omniture segment to Digital Marketing and combined it with our Enterprise segment. These changes reflect our focus on our two strategic growth opportunities. Our Print and Publishing segment, which contains many of our mature products and solutions continues to be reported as it was in fiscal 2011. Prior year information in the table below has been reclassified to reflect these changes.

We have the following reportable segments:
Digital Media—Our Digital Media segment provides tools and solutions that enable individuals, small businesses and enterprises to create, publish, promote and monetize their digital content anywhere. Our customers include traditional content creators, web application developers and digital media professionals, as well as their management in marketing departments and agencies, companies and publishers.
Digital Marketing—Our Digital Marketing segment provides solutions and services for how digital advertising and marketing are created, managed, executed, measured and optimized. Our customers include digital marketers, advertisers, publishers, merchandisers, web analysts, chief marketing officers and chief revenue officers.
Print and Publishing—Our Print and Publishing segment addresses market opportunities ranging from the diverse publishing needs of technical and business publishing to our legacy type and OEM printing businesses.
(in thousands)
Digital
Media
 
Digital
Marketing
 
Print and
Publishing
 
Total
Three months ended March 2, 2012
 

 
 
 
 

 
 

Revenue
$
730,294

 
$
259,896

 
$
55,030

 
$
1,045,220

Cost of revenue
26,973

 
78,276

 
3,016

 
108,265

Gross profit
$
703,321

 
$
181,620

 
$
52,014

 
$
936,955

Gross profit as a percentage of revenue
96
%
 
70
%
 
95
%
 
90
%
Three months ended March 4, 2011
 

 
 
 
 

 
 

Revenue
$
761,110

 
$
212,900

 
$
53,696

 
$
1,027,706

Cost of revenue
30,648

 
74,329

 
2,662

 
107,639

Gross profit
$
730,462

 
$
138,571

 
$
51,034

 
$
920,067

Gross profit as a percentage of revenue
96
%
 
65
%
 
95
%
 
90
%
NOTE 16.  SUBSEQUENT EVENTS
 
Subsequent to March 2, 2012, as part of our $1.6 billion stock repurchase program, we entered into a structured stock repurchase agreement with a large financial institution whereupon we provided them with a prepayment of $225.0 million. This amount will be classified as treasury stock on our Condensed Consolidated Balance Sheets. Upon completion of the $225.0 million stock repurchase agreement, there is no rem